Chit Chat Stocks - Docusign (DOCU) | Not So Deep Dive

Episode Date: February 8, 2022

Docusign allows organizations to manage electronic agreements. The company provides digital solutions that enable businesses to prepare, sign, and manage these agreements. Listen closely as Ian, Brett, and Ryan go through the history, financials, and future prospects of Docusign. Enjoy the show! This episode is sponsored by Commonstock, a social network for smart money investors. Check-out the platform here: https://commonstock.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to 7investing with the code "CCM" and get $10 off: https://7investing.com/subscribe/aff/4/ Interested in more of Ian's work? Follow him on Twitter: https://twitter.com/IanGrayLive  Contact us: [e-mail] Timestamps Company Background | (3:48) Industry | (10:25) Management & Ownership | (12:21) Valuation | (17:27) Earnings | (18:40) Balance Sheet | (22:36) Our Analysis | (25:47) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not-So-Deep-Dive episode on Chit Chat Money. This is the show where we go over the basics of a stock in about 45 minutes. Hopefully, by the end of

this episode, you won't be an expert on a company, but you'll get up to speed and kind of decide whether this is something you want to research further. That's the goal of this show. And today we're talking DocuSign, a well-known company. I think everyone knows about this company now, right? Are you guys nodding in agreement with it? Yes, maybe, maybe not. But they say they have a billion users, which is a funny way to describe a user, but it is DocuSign, the e-signature company and the cloud agreement company. And I'll let Ryan get into more of that. But Ian, have you looked at this company before? I know Ryan was kind of this is on his watch list a few years ago something like that but ian has this been on your

watch list or in your holdings at all yep so it actually is a current holding of mine um it's a fairly small position i started started it a couple a few years ago i want to say in 2018 maybe so um but i think i think today i'd have to look for the exact number but i think it's somewhere around a one percent position all right well congrats it's been a huge pandemic winner so that has probably put up some great returns for you. Ryan, have you learned, you knew about this company in 2019 or so you were following it, if I remember correctly. I probably was. I kind of don't remember. This is my first time really looking at it in a while. It's pretty talked about in the investor community, I guess. That's true. Full favorite, pretty popular

among a lot of retail investors. And I'll let you introduce what the company is. But first, we have to talk about our sponsor, Common Stock. Today's episode is brought to you by Common Stock, a social network for smart money investors. If you want to check them out, go to commonstock.com today to join. I actually have it open right now. I'm going to just kind of go through and see what I got looking on here. You have trending tickers. You have someone named, I know this person, I've seen him on Twitter, Nathan Warden with 310 million in follower assets. And now that's an important thing about Common Stock is they connect your brokerage account. So whoever's following you, you know, how much money is following your account. So this is a, and it's not,

it's not peanuts on there. He had a question about Spotify. They're doing a video on it and they have a lot of questions on it and you can comment and communicate with people about these things. And people will write reports on stuff or maybe link to other reports they're doing. And you can discuss on all these things. And it's not a lot of the fluff that you might see on Twitter. It's actually in-depth discussion. You're not limited to the 280 characters and you on Twitter, it's hard to have a real good discussion. This is where you want to do it. And you know that people have skin in the game because their brokerages are connected. Very interesting platform. We're going to hop on there soon and probably do some posts as well.

It's a pretty interesting platform. Ian's a user. Ian is a user. Ian's posted before. So check him out on there. It's a great way to put, if you're looking for a place to read long form research and either post your long form research, This is a great community to have that because you know the people on there are going to be interested in investing and all that stuff. So if you want to check out Common Stock, again, go to commonstock.com. Ryan, do you want to introduce DocuSign? Yeah, DocuSign is a software-as-a-service business that offers a few different solutions. They span across what they call the agreement cloud, I think is the term they use.

But it's really the agreement process from setting up documents to analyzing the documents and the important parts of it, like maybe certain legal tidbits in it, and then signing it digitally, which is really what their main service is. That's the e-signature solution. And you can sign an agreement on pretty much any device anywhere. It's very easy. And that's typically the first product that customers are looking to get. So from there, they try to cross sell a lot of their different solutions. And so some of the other things within their agreement cloud solutions are the contract lifecycle management.

So this is applications like Insight, which it's AI is the term they use, AI that basically picks out the important parts of a document. There's also Analyze. So it can kind of, if there's a lot of legal speak, it can help you understand what you're signing. There's also identify, which is, I might be getting this not exactly right, but it allows identity verification for some of these things using like government ID scanning, I believe. There's payments.

So after you've signed a document, if you want to just pay for something right through DocuSign, you can. There's e-notary. So you can notarize things digitally or just remotely, which for those of you that have had anything notarized. That's already, I'm going to say it right now. It's my future growth opportunity because notaries suck. It's like e-signature. It's pretty easy to see how this could go into the digital realm and save people a lot of time. Yeah. And then there's also a few vertical specific solutions. So they target certain industries and have different, I guess,

products that are set up specifically for them. And then DocuSign targets businesses of all sizes. So today they have 1.11 million total customers and 160,000 of those are enterprise level businesses. DocuSign's go-to-market model consists of direct sales teams all over the globe. So they set up like real sales centers. And you can see that they actually have a fair amount of capital expenditures or purchases of property and equipment. I think that's probably the office build-outs. And then they also have partner-assisted sales. So this is like companies that use Google, Microsoft, Salesforce. They have basically inroads with them where they can easily just adopt DocuSign through those platforms. And then there's web-based sales. This is basically

if a user just needed to send over a document, wanted to try something out, they could just look an e-signature provider and they'd find DocuSign. They'd also find a few others, but DocuSign would be on there. Another interesting note that I saw is 70% of their employees are in sales, marketing, and customer success. So those departments, I guess. So it's very much a sales organization. The primary tool is the e-signature function, but they are cross-selling some of these other solutions. And they have a really high, I guess, in terms of pricing, I tried to look it up. It's not a per user model. So it's really capacity based. So you get like a certain amount, you buy a certain amount of signatures, you prepay for them. They might call them envelopes too. Like

they call them digital envelopes. Yeah. And so you prepay for those. And once you exhaust them, I imagine you have to buy a new bunch of them. And so that's basically the model. And so you can imagine during COVID, there was a lot of expansion within that where a lot of people paid up for more envelopes. And then you also just get a new subscription price if you use a bunch of the different features as well. And then history about the business. I thought this was absolutely hilarious. So DocuSign's history page, I'm going to pull it up because it's absolutely criminal. It's DocuSign history. All right. I'm pulling it up too. Let's check it out. DocuSign history.

Wikipedia. Oh, the history of innovation, huh? There we go. So it starts with Eli Whitney and the Machine Age in 1798. Correct. The birth of the London Underground in 1854. The Transatlantic Telegraph, 1856. Ford and the mass automobile market, 1913.

1991, creation of HTML. There wasn't anything in between. 2003, DocuSign founded. I'm sorry. You weren't even the original e-signature provider. There are other companies that had this. Oh, yeah. That's why I look at Telegraph, automobiles, internet, digital signatures.

That's my four big innovations of the last 200 years, right? I thought that was a little ridiculous, but I guess more on the history. DocuSign was actually started in 2003 by a Seattle native named Tom Gonser. He had another company prior that he had been the CEO for, and this is actually three years after the US legalized digital signature. So I believe it was legalized in 2000. And he started it by acquiring a company called DocuTouch, which had some patents and solutions around digital signatures.

And then they made their first sale in 2005. The history in general is pretty uneventful. It's kind of like the average software business. They constantly innovated, added a few new products, either through development or acquisitions. And then they just kind of evolved their sales teams over and over and they just grew constantly. I guess other notes, they made three recent acquisitions, all about $200 million or less. One of them was actually much smaller. I think it was 38 million. And they all provide basically tangential product. So it's a lot of the products they offer today in their bundles

come through these acquisitions. That's kind of how they got bolted on. And so I think that is a strategy that you could probably expect to see in the future with DocuSign. Other notable things that I guess they came to the public markets in 2018. That's when they made their debut. They've had a few different CEOs throughout their history, but Ian will touch on that. That's pretty much it. Brett, you want to hit industry landscape? Yeah. I should note that management did say that they are going to pursue M&A. I think they mentioned it in one of their recent investment conferences in the transcript. So that is correct in your assumptions there, Ryan. All that industry, pretty easy. E-signature market,

it's only about $2 billion to $3 billion in spend right now, but it is expected to grow at a 20% CAGR to $6.9 billion in 2025. Many competitors out there, especially just for the core E-signature product. And that's because that core product is not too hard to replicate. If you wanted a really bare bones one, I think someone, 10 developers or even one really good one could probably do it over a short time. But we'll talk about how, whether it's really about the core e-signature or it's about the ease of use, the ancillary products, all that stuff. But their most important competitors are Adobe with Adobe Sign, Box, who just started it, who's not really a big competitor. But another big one is HelloSign, which is in Dropbox or a part of Dropbox.

So those are the big competitors because they're really competing with the other companies that have these bundles that they can sell to people. And I'm sure we're going to talk about that in the second half, but that is why DocuSign wants to build their bundle to make it just as compelling on these other ones. Management did say though, that their TAM is $50 billion. That's a little bit higher than what I'm seeing out there, but maybe they're just including all their ancillary products that they're going to market right now i hate tam talk tam talk yeah they talk about 50 billion dollar tam we just recorded axon enterprise uh with brad that came out before this and they were the most tan happy company i think i've ever seen yeah it's

like they talk year over year tam growth and then their revenue growth's like flat and it's like who gives who cares about your tam i know we'll focus on someone else's tam too yeah uh either way, though, e-signature market and this agreement market, which is kind of a broader overview with e-signature being their core product, it is a fairly large market that is growing really, really quickly. I think that's the core thing to take away from this industry and competition talk. Management and ownership, though, Ian, do you want to talk about their executive team? Yep. So Dan Springer is the CEO of DocuSign, and he became the CEO in January of 2017. previously he was the ceo and chairman of a company called responses which was sold to oracle

for 1.6 billion dollars in 2013 so he's he's kind of been a little bit of a software um executive for for a few for a good portion of his career now um he actually started as a consultant at mckinsey and after that has worked in many software as a services companies and like i said And most notably for Responsys, which was sold for $1.6 billion in 2013 to Oracle. He's also on the board of a company that you see on Fintwit sometimes called UiPath, which was kind of interesting to me that he was on kind of another fairly large publicly traded company's board. Kind of looking into the proxy a little bit, there's some hefty stock awards for the entire management team that are based on performance. but most of the performance metrics, there was a fairly low bar to actually get the bonuses.

And so that's always something that makes me laugh a little bit when looking through a proxy statement, when they're like, Oh yeah, 90% of our, you know, compensation, 90% of our executives compensation comes from performance bonuses, but then the performance bonuses like the target is basically flat revenue growth or something like that. Right. Like that, that just, it's nothing. Padding themselves on the back. Right. Padding themselves on the back for, you know, a quote unquote performance bonus, but they would have really had to mess things up not to get it. So last year in fiscal year 2021,

Springer earned nearly $19 million in stock awards. And despite being a hired CEO, he has nearly a 1% ownership stake. And that that's even after selling quite a few shares in 2020. um in addition to springer there's a couple other big shareholders but the biggest shareholder is vanguard with over seven percent of shares outstanding but even vanguard ended up selling nearly 17 of its stake in the last filing period so um a little bit of a reduction in its stake arc is also a shareholder i think arc owns about one and a half percent of the company and so it's kind of an interesting mix actually that it has some of the some things like vanguard and you'll see on its, um, kind of in its public holders that there's, there's quite a few, there's

a mix of things that are more focused on kind of growthier things. And there's also some, some, uh, companies that are focused on probably not, not quite value, but there's, um, kind of some more growth at a reasonable price type, type investors and DocuSign. So, um, yeah, that's management and ownership. Now Vanguard, it could have been just a passive rebalancing with the stock down, or is that, was that a different filing period? Could that have been of it?

It could have been. And yeah, it could have been a rebalancing with the other stock being down. All right. What are our thoughts on, what's his name here, Springer, buying the dip, quote unquote, in the open market right after the stock tanked? I know Ian, you probably follow more closely than us. What were your personal thoughts on that and kind of his communication around it? So I think it's generally a positive sign, obviously, when a management team is buying

a stock and it's a bullish signal. But I would also say that, like I said, he had $19 million in stock awards in fiscal year 2021, that sometimes I think those stock buys can be overblown, that it's like everybody knows that it's a good press release item now too. And so, I don't know. I take it with a little bit of a grain of salt. I'm not just, I don't just pour into a stock because an executive has bought into it. True. Yeah, it doesn't change the business. That upsets me sometimes when you report like a truly bad quarter and then you buy it almost to like, it almost feels like you're just doing it for optics.

Like everyone sees that I'm confident, so they'll buy. Even though I was just granted a bunch of stock last year and sold it prior to this. like yeah but his on a on an investment conference i was reading he seemed a lot it's hard to tell because we don't talk to him but it seems like he was a lot more rational about it they asked about and he said well i thought it was cheap and if it goes lower i'll probably buy more i tend to not look at the stock price i try to only look at it once a week on friday um but now i'm looking at a little more frequently because i might buy it but he said it sounds like he's a business focused guy which i think is good but again it's hard to tell um since we're

obviously not in personal touch with him right and just to provide a little bit more context on that too he he bought about five million dollars worth of stock at prices ranging from 140 to to 147 dollars a share so um actually prices that are significantly higher than what it is today today docusign is it like 120 it's up a little bit today but about 123 dollars a share do you how much he sold he sold i can get that number in a second i can i'll pull that up all right i'll end evaluation yeah while you do that um market cap 23.2 billion dollars ticker docu this is probably a classic company that people are like oh e-signature company is worth 20 billion dollars like you know what i mean like there's an e-signature company it's worth that much money

it's like i mean they actually generate a lot of cash but uh besides that enterprise value is approximately the same as market cap. So no use really of going through that and changing it up. I'm going to use Billings as their sales, quote unquote, because they defer a lot of revenue. And I think Billings is a better, which is just revenue plus change in deferred revenue. I think that's a way better metric of their actual top line. So with that, price to sales is 10, price to gross profit, 12.3, price to operating income of 53, 14 million total dilutive securities outstanding versus 198 million current shares outstanding. So going to be some dilution. Their granting pays is pretty decent. They have a gigantic sales staff. So expect dilution going

forward, but that's just part of the deal here. Not egregious like a lot of other high growth companies we may have followed, but still going to be looking at that maybe 1% to 2%, maybe slightly higher dilution going forward, which isn't crazy. Brad, do you want to hit earnings? It's the dilution has been pretty like constant since I went back and looked at 2019. And it looks like it's been probably just off the top of my head around 10% dilution since. So I would say maybe low to mid single digit. Well, I mean, looking at their total dilutive and looking at, I don't have the granting pace in front of me, but just looking at it now with their total dilutive securities outstanding, which includes the convertible notes versus $198 million. Yeah. So, I mean, you know, I think.

That's like what? 8%? I know, but it's not going to invest right away. And looking at their granting pace, I mean, it could be higher than 2%, but, you know, we'll see. Either way, it's just a part of the deal with these type of companies. Yes. And I imagine Ian will be talking about some of the convertibles, but I'll get into the earnings. So total third quarter billings were $565 million, up 28% year over year. Revenue is slightly behind that, as we mentioned, at $546 million. And then gross margin was 79%. And they

did generate strong cashflow margins in the quarter, about $105 million in operating cashflow. That's 19% operating cashflow margin, 90 million in free cashflow. And as I mentioned, they do spend a fair amount on property and equipment, not an insane amount, but there'll be a little difference between operating cashflow and free cashflow there. And then they also spend money on acquisitions. So keep that in mind. Had a dollar-based net revenue retention rate of 121%. They have had historically a pretty strong net revenue retention rate number. I do think some of that is from, we saw it kind of peak during COVID because people were probably buying more envelopes. It might not necessarily be them getting into new products as much as just expanding their

usage of the e-signature solution. Could be bumpy over the next few years. You never know. Yeah. And they saw strong growth internationally as well. So 68% revenue growth year over year. And then it now accounts for 23% of the top line. So pretty material. And then Total customer count grew 35% year over year. It grew slightly quarter over quarter. It was a little hard to tell because they didn't give a precise number in Q2 that I saw. Full year guidance, they're expecting about 2.34 billion in billings. That's a 38% increase from last year. They're going to expect similar gross margins to what we saw, that 79% figure. I will note though, however, And the reason if you want stock, you sign after the last earnings report, it dropped like 30, more than 30% in a day. And I think the reason for that was Billings quarter over a quarter. And this might be a slightly seasonal business. I'm really not sure. Billings dropped 5% quarter over quarter.

So even though it looks good year over year, if they're actually sort of in a quarterly decline and they said their full year or their fourth quarter estimate was still below that Q2 figure, that's probably what investors were kind of focused on. So you may want to, and like I said, there might be some seasonality in here, but you may want to look at that quarter over quarter number as well. Definitely, definitely growth slowdown. That's really the only reason why the stock dropped. International though is interesting.

I didn't know this about the signature market. Maybe I should have, but it's a lot more regulated than you might expect. You really have to get into these markets with all these special things and even with the languages and all that stuff. So it's not as easy as say someone like Facebook and just saying, okay, we're going to launch in 180 countries. It's pretty easy. We just have to get up and running. There's a lot more red tape to getting DocuSign launched. So I think they're only in eight countries right now. So international is definitely a huge future growth opportunity. Eight might be the wrong number. I think I remember reading that, but either way, not a big amount of countries. Ian, do you want to finish up the first half with

balance sheet? Yep. DocuSign has $908 million in cash investments, and I included long-term investments in that. I think it was about $90 million in long-term investments. They've got $901 million in debt, $171 million of which is leases. So you can back that out if you don't account leases. And then they have $50 million in convertibles that are due in 2023 with half interest. They ended up paying off most of these with proceeds from 2024 convertibles that I'll talk about in a second. And they also hit the conversion price on those. And so I would expect that the rest of that would get converted here, but they've got the conversion price on that was about $71.50 a share. And they issued those in 2018. They also have about $690 million in

convertibles that are due in 2024 with 0% interest. The conversion price on these are $420 a share. So almost more than a 3x from the prices today. And they issued those in early 2021. And so like many of the companies that we've talked about that did 0% convertibles in 2021, um they're able to raise at the peak and um basically get some free money for a few years yeah you need a little golf clap for that cfo that's impressive work it is it is zero percent interest 420 uh strike price and um or conversion price and uh they still need 120 today they did do capped calls come on guys come on same though you know what golf clap for the cfo but that's a tis tis on whatever bankers they're bullish it was a new paradigm you didn't know that was

maybe yeah hey at that point stocks only went up so that was true hopefully they didn't if it was it do you know when the date was was it february really i think it was february wow nice i think that's what it was i could i could pull that up in a second too but um to touch on kind of our previous conversation. Um, he basically, he went from a, about a 1.3% position in the, uh, company down to about a 0.8%, uh, position in DocuSign. So about, um, a third of his holdings, some of that may have been tax related. I just, as he was exercising, some options may have, um, needed some of that to pay off taxes, to pay taxes on those, uh, the exercise of the options. But, um, but anyways it did it did decrease uh substantially but then also the the rate or the open market

acquisition that i was talking about was in december and it was right after the earnings call and he did about five million then he bought about um another chunk um in january about a month after that first buy and so he did double down and say he was true to his word he was true to his word that hey if the stock drops i might buy some more and he did so uh that's good to see him actually follow through on that. But yeah, he seems to be confident in the company. There's no other way to really say that. That's true. He said in the investment conference, almost his entire net worth is tied to the company. So, you know, risky for him maybe, but good for shareholders, I think. All right, let's take the ad break. This episode is brought to you by

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with cox panoramic wi-fi advanced security must be enabled in the panoramic wi-fi app restrictions apply okay welcome back in next up we have anecdotal evidence ian uh you've used signatures before i'm assuming uh what are your thoughts on doctor's side yep i think like most people um probably have a similar experience to me but it's worked perfectly fine for me nothing special nothing too fancy but i wouldn't say there's anything that really differentiates it from um adobe sign which i've also used it like i i just get on and i use whatever the as from the user experience it's just they all seem basically the same to me that it's It's a digital signature and I use it and it works and it's fine, but nothing special.

Yeah. I was using, I was checking out Gartner. They both have like the same reviews. Really, really close. Ryan, what about you? What are your thoughts? Yeah. Same as Ian on the user side. I'll sign whatever people send me. I don't really care what the solution is. I'm not like- Some are bad though. Some are bad. Are they? The non-Adobe's DocuSigns and HelloSigns. I've had some ones that are bad. Interesting. Yeah. like poor product quality you know what i mean worse than having someone fax it to you well no

not as bad as that it's but it's just not like some of them are bad i just have a bad experience yeah i uh i don't know i don't really care what i'm saying i guess as long as it's not terrible and then um on the business side if we were to pick one because i think we've i think we've used them before um well i think we were a user but not a payer like someone sent it to us you know okay like but we be paid for the adobe bundle i'm pretty sure yeah i was gonna say i think we use i think we've sent some um before no we have yeah but i thought you're referencing docusign you're saying adobe's yeah that's what i mean so yeah on that side it's like i basically if i'm picking one i'm just gonna price shop and then and adobe's is basically free that's what i mean

if you're gonna we already use adobe to edit the audio for these podcasts and so if you're using something that's Adobe-wise. And PDFs. We use other products too. Yeah, I guess there's like no reason not to just bundle it. And that could potentially, I guess that could be seen as a low light is that Adobe, although it

might not be the largest e-signature provider right now, it has a massive install base through all its other products. So them being able to bundle, I think, is a real threat. And they don't price on per envelope. So it's hard to tell who has the market share, but it seems like an easy product. I agree with

you know, that on stuff seems like the big thing for us. Um, I don't know if I'd switch over if I was already a DocuSign customer, if I was in a business that used signatures a lot, but for us, who's rarely using signatures, but has to use them sometimes. Um, it's just, it's fine. There's no reason for us to use DocuSign over Adobe when it's included, but I don't think we're, that's just our anecdotal evidence. I think there's a lot of businesses that aren't in the creative, um, realm that would like not need any Adobe products or, you know, maybe just PDFs. So there might be a lot that don't. Yeah. And I also, this is part of, this is a part of the DocuSign business that I don't understand intimately well, which is the API side and

integrating this into really big businesses, because there is even, they break out this on revenue. They have a professional services side, which is they go into big customers and they integrate this as a part of their day-to-day operations because the companies can't do it themselves. Is it more developer-friendly than maybe Adobe Suite? That's true. I was looking up their API thing. It looked fine. Ian, have you researched that at all, their API tools? I haven't looked into their API tools at all. No. It seems like a small part of their business, but that could be like their focus could allow them to be better for custom solutions and stuff like that all right future growth opportunities and what do you have for us for DocuSign

yeah first I just actually want to touch on that last thing you said because I typically get pretty excited by companies that have um APIs and things that allow people to create their own whether it's white labeling or their own solutions or or it becomes more of the platform that someone else can use to then build the business off of with DocuSign I'm not sure um you know maybe we'll get to a point where that that is more important but i'm not sure that the api piece i i don't understand quite the value chain there that it seems like you just use the solution it doesn't matter if it's integrated into your like you can have partnerships as they do and i'll talk about those later but i'm not sure that it matters as much um like if it's

like if it's integrated in the bank of america it doesn't matter if it says Bank of America's, or it's just a separate DocuSign thing. Right. I don't think customers really care about that. I'm not sure what value that adds to a platform that it's like your own versus just a partnership with DocuSign. But anyways, the future growth opportunity that I want to talk about is centered in this idea of what they're calling the smart agreement cloud. And so initially, they talk about being an e-signature solution. And then over the last couple of years, really as a public company, they've tried to expand from just being an e-signature solution to the agreement cloud.

Now they're trying to expand into what they're calling the smart agreement cloud, which is going to use AI, other types of tools. And so the piece I want to talk about today is called DocuSign Analyzer, which purports to help people quickly go through contracts and pick out the key terms. It also will do risk assessment scores and access any of a company's pre-approved library of clauses to reinsert into the contract. And so that instead of having to go back and forth or get lawyers involved or a contract person involved, the DocuSign analyzer should really limit the amount of human interaction that's needed to negotiate these contracts. And I use air quotes there because at that point, it's not even really negotiation. You're just

doing a little dance but um as part of their expansion plans um this is kind of a key piece of that that it's it's about automation less human interaction that you have this agreement that's kind of coming together but that a lot of it's going to be automated from your end um i'm the only you know i'll caveat this that i'm not sure exactly what the demand or the the trust in a tool like this would be that like if you're really trying to sign a contract it seems like it's going to be a fairly high hurdle to the amount that that you'll just let it do its thing on its own that there's going to still be human interaction and i'm not sure how much time it really saves when you're having to go through and like check to make sure that the the automation

is correctly working now maybe if you do it hundreds of times then you start trusting the automation a little bit more but it seems like there's a little bit of a high hurdle for companies to really adopt something like this. I think you're, that's a good way to frame it is the high hurdle because we've used, um, when we were signing a document, I don't, I don't know if it didn't really like analyze everything, but there are usually when there's an important legal document, you're going to read through it. Um, and maybe not every layer of a big corporation, but you don't want, I feel like it's usually pretty important to your life and you don't want to just risk missing something because the automation didn't catch it well maybe chinese

companies but thousand page 20 f's i don't know you know yeah i don't think that's what you're referring to that's a they gotta sign those you know but no that's a joke it's all serious i agree with yes the uh yeah that that is an interesting one though and i'd be curious they didn't i haven't seen them give any numbers out on it but i'd be curious to see how much customers are really adopting that solution so far um i guess i mean look in that retention rate that's probably the key number you know over time yeah but that retention rate number includes a lot of different stuff too yeah okay yeah not specifically to that one yeah it could be yeah i would think just that's just a key to looking at if customers are adopting more products in general yeah um so my future

growth opportunity. I'm going to go with the e-notary. So this one, unlike Analyzer, I think this has pretty low hurdle to get there. The service was basically non-existent until COVID. And it seems like one of those areas that's just bound to go primarily digital. It feels like e-signatures 20 years later, just all over again. And I think there is sort of that red tape barrier that along with the notary stuff, as well as there had been with the signatures. and I think COVID probably eliminated a lot of that and that was probably really good for their notary solution.

They highlighted this, they really harped on it in their conference call. They talked about how big of an advantage it is for like banks, for example, to be able to have the identity solution, the notary solution and the e-signature all for their customers and it reduces a ton of friction for the bank's customers.

So I think that's just a really big opportunity, especially in real estate, insurance, financial services. Also, last year, it said more than 20 states had offered it. They offered it in more than 20 states. I'm curious to see what that number is going to be when the 10K drops this year, because I imagine COVID propelled a lot of states to adopt the e-notary. Maybe it's just DocuSign rolling it out slowly, but I think there's a lot of low-hanging fruit there. And that, for me, intuitively feels like the easiest thing to cross-sell after e-signatures. Yeah, for a lot of companies. And the regulation part is nice for a scaled company like DocuSign where it's harder for a new entry to come in and

compete with them. But I'll hit mine. It's pretty simple. It's not a product. It's the expanded partnership with Salesforce. They just talked about this. Now, partnerships aren't everything. And sometimes I think, well, I think a lot of the time they're overhyped. But in this case, it makes a lot of sense for them to kind of cozy up next to Salesforce because people who use Salesforce typically have a lot of things that need to be signed. It looks like DocuSign's strategy from my purview is they want to bundle in with these existing applications because that's That's their big weakness compared to someone like Adobe or even Dropbox and others. And I'm sure in the future, Microsoft could come out with a signed solution.

I'm curious to, it's curious why Salesforce or Microsoft don't have signature solutions. I wonder why that is because it seems like they could kill DocuSign, but. I was going to ask that is, do you think this puts DocuSign almost in a precarious spot where Maybe the terms of those agreements are super nice For the big companies Because if DocuSign ever tries to I don't know how those agreements work out I think DocuSign is too big now

If they were smaller maybe They got a lot of If they tried to raise prices or something You don't think Salesforce would just go out And buy a signature provider on their own? That's what Dropbox did Well, that's different Salesforce is more

I think Salesforce's customers would be pretty upset because I bet the solution is not nearly as good as DocuSign. Okay. But who knows? Who knows? I'm not in that industry. But either way, I think that's their big weak point. Yeah.

It just seems like it's like an advantage in collecting or in getting new customers, but at the same time, it seems like they're at risk. Yeah. Either way, I think Salesforce would rather just acquire DocuSign. Yeah. They acquire every company. Anything that helps them, they'll just acquire it. Yeah.

Yeah. Highlights, lowlights. Ian, I guess you own the stock, so you may have a lot of highlights, but what do you like and dislike about DocuSign's business? Yeah. So I think the highlights is it's a successful business today with a great product. You know, it has, you know, they cite their net promoter score. I think it's at 72. And so people like the product. It works. It's made, it's undeniable that e-signature solutions like that have made the world better. I would say that it's also encouraging that it's starting to break out into more of a multi-product business. But it's still really early in that. And I don't know that... I wouldn't quite be comfortable saying that DocuSign has

really captured this agreement cloud. I think it's trying to get there, but I don't think it's done that yet. It's got strong gross margins, generating free cash flow. And I do like the integrations that you were talking about. It's integrated with Microsoft Teams as well now. um, the Salesforce one you were just describing. I think that's good. I think that there's a potential here for, um, an acquisition at some point, especially with the hit that the stock has taken, um, that there could be, you know, it's in the range of some of these Salesforce acquisitions that have been made. I would say that, um, Microsoft would be another company that could potentially try and buy this. Um, you're always dealing with the regulatory hurdles

in that case. But that might go to explain some of the stock buys by the CEO as well, if he thinks that there's somewhat of a floor here on valuation related to potential acquisitions. Who knows? That's all speculation. But those are a few of the highlights. A couple of lowlights for me is it seems like margins could be better. I know that they're ramping up the sales efforts, but they spend about 62% of revenue on SG&A, whereas it's about 35% for Adobe. And like I that's understandable much lower revenue um base for docusign than for adobe and docusign's really in more of a growth mode than adobe is but that being said it just makes it a little bit harder to win that battle when you're having to spend almost um twice as much of every dollar of revenue

um adobe could kind of like they could accelerate their expenses and kind of try to you know they They have more room to do that. Right. Adobe has significantly more scale than DocuSign does. And so it just makes it difficult to compete with them on, you know, advertising and then it hurts profitability in the short term as well. So they're playing a little bit of a game of can we get to that level of profitability before and build enough revenue over the next couple of years before we get kind of pushed to the side. Yeah. All right, Ryan. Highlights. It's better than an analog signature. And I know that sounds obvious, but I think, especially when you think about international markets, there's probably still a lot of low hanging fruit and just customers that, I mean, if you look at the e-signature market thus far, all the players, they've all grown a lot. And I think that's just because e-signatures in general are so much better than faxing stuff over or signing it and scanning it.

And so I do think there will be sort of a natural rate of adoption that continues to grow or at least provide some continued growth for them. I also think they're on the fence of being a verb, which I imagine is great for SEO and sort of just web-based adoption. uh, other things. I do think that acquisition candidate thesis, I guess, could be real. Um, and it does feel like something that Salesforce would buy, uh, low lights for me though. If you read the conference call or listen to the conference call, it feels a bit strange. And Dan Springer obviously knows the business better than I do, but it feels a bit strange for them to be investing heavily into a demand headwind like they talked about this big demand slowdown post-covid like that you know the billions are down five percent quarter over quarter

investing heavily into that seems wrong to me it seems what's the investing heavily like what did he have any details on that expanding sales spend i'm guessing it i mean that's what i was reading was the expansion of the sales teams and it wasn't it was kind of a people asked him that people asked like what exactly does that mean and it was kind of like a blurred response they're like how much like growth or in sales spend should we expect and he's like base i don't know it was kind of like it felt like maybe they were just going to invest time into retraining but it was a little difficult to understand they also said that they hit they already hit the long-term margins they want to get to, which I think CEOs do that as a humble brag sometimes. And it's not

what investors think. Like in my mind, this is a business that could have had a ton of margin. It can be like Adobe. Yeah. But then when maybe it's to Ian's point, which is they have to spend more on marketing or sales than an Adobe and 18% margins as the ceiling or 15% free cashflow margins as the ceiling. That's not what I would have guessed as an investor. So I'm just curious as to like, why can't you, why is that your long-term sort of margin at scale? Yeah, there's a big hiccup. I think over 50% of their gross profit is spent on S&M right now, which is high. All right. My highlights, durable and growing industry spend, which is just an easy tailwind for them to ride.

great margins that have expanded it seems like it'll be at 80 probably inch higher uh i think they're decently high switching costs too which is great especially for the enterprises if you're doing these all the time like you're not switching out unless like i think it's harder to compete to get someone to land someone because adobe dropbox whoever already have those established bases but if you're already using docusign i think it's really hard to switch unless they start giving you a big time price increases because there's just no reason, even unless going to Adobe would save you a ton of money, which I don't think it really would. Lowlights though, competitive dynamics, I don't really know who's going to win the market. It's kind of hard to

tell for me. I think it's just a bit of a black box. And then looking at their product suite, I don't know why I just kind of get like, eh, is this something, is this a company or is it a product kind of feeling. I think they're trying to work from being a software product. Over the last few years, they've worked really hard from being a software product to becoming a software company. But I still kind of get that feeling compared to when looking at someone like Adobe. But overall, I think it's hard to find any lowlights besides being confident in whether they're going to be the winner in this industry. It seems like a real layup, like industry was such a big tailwind at its back.

it okay this is kind of a concern for me is that did you did you look at the conference call at all no i just read the investment whatever uh those you know banking conferences it it seemed you could tell why it dropped 30 after the earnings and it was very um it felt like they were trying to almost like everyone was asking like wide growth slow essentially and they were like don't worry like we're going to spend a bunch of money and we're going to get growth back up it felt like this is a business that has to keep growing or they're in trouble um but it's not it doesn't look true yeah but it's not like fubo but yeah i mean i wouldn't think it's true either but i was kind of curious as to why then on a demand headwind do you start investing again in sales

like spending more in sales i mean that could be a management low light um yeah i don't know i'd much rather just be a durable 15% grower with good margins than trying to bloat your head employee account and grow at 30%. You know what I mean? Yeah. I don't know. I don't know. Long run.

It's not a giant difference. Yeah. If the quarter over quarter stuff, like if let's say they like these investments didn't work and I guess I'll just use this as my bear case. And then I'll talk about my bull case after, but the say the big investments they make into this just don't work. and demand has kind of like saturated, especially in the US, like the year over year numbers are

going to start to look worse come three quarters from now. And they already guided for that fourth quarter. That's going to be worse than the second quarter. So did they kind of peak and are they trying to like keep it going even though COVID was a huge boost? That could be true. I just don't think it's true. Not only do they have a million customers, there's what a hundred million businesses worldwide all of them no not all i'd say probably most of them are going to need a signature product i think docusign will you know keep up their market share but it's a possibility yeah and our billions billions are you know i mean they have to fight off decreasing spend probably maybe i don't know if i'm not sure i'm not sure all right well maybe what's your what's your

bull case Ian? My bull case is that the smart agreement cloud idea actually does gain widespread adoption and DocuShine captures a significant share of that market with, you know, leading to 20% growth in revenue over the next three years, 25% free cashflow margins, which may be a little bit high, but I think it's doable. And at about a 3% free cashflow yield, that would only yield a seven and a half percent three-year CAGR over the next three years, if they were able to hit those numbers which um is a little bit concerning to me um but and and i'll get more into this in the bear case i'm more or less interested but um but i think the bull case i think the bull case really hinges on it hinges on them actually breaking out of just the digital signature

that they have to get into this agreement cloud or smart agreement cloud type business yeah i agree potentially potentially that's my i mean that's my big thing is that they're able to cross-sell some of these solutions and it isn't just like because maybe companies don't adopt the clm plus bundle or whatever the the insight and analyzer but if they if you can get them to spend as much on the e-notary as the as you do with e-signatures that's a huge cross-selling opportunity um a little bit smaller market but still pretty big market right and so yeah yeah i mean those three you think about the use cases for banks like that's huge i mean being able to do that digitally is a big i imagine

it's a huge market um so i mean that for me or international expansion uh the fact that they're only in eight countries i forget which one of you said that that that was i think i read eight countries but they're gonna try to get as many as possible yeah surprising to me because i imagine And this is kind of an inevitable market for a lot of countries. It's the regulation. That's why. It takes a long time. It's just a matter of time.

It's sort of a when, not if. If they can do that and their dollar-based net retention rate is able to stay above like 110% to 115%. If it's 115%, sorry to interrupt. For the next five years. I think their revenue growth will be quite high if it's 115%, just given the amount of customers they can go after. Their overall revenue growth, I think, would be quite high. Or maybe that's what you're thinking you need to forecast for the bull case. Yeah.

I imagine they're going to grow customer count probably around 10% annually for the next five years. You do that, couple that with 15% increased spend on your existing users. that's probably a recipe for a good adequate returns yeah i'd agree i'd agree i'm in the same range i think you gotta expect 20 revenue growth or higher um you gotta be able to forecast that though and i think margins are interesting it's disappointing they said that their long-term margins are where they should be at because that makes no sense to me uh because it seems like this can be an adobe type business 40 plus margins out there but there obviously is a lot of variance if They don't have that confidence in them because really, does that mean they're going to have

the sustained sales and marketing spend? I would hope not. That is a concern if it would be though, because that just means the business isn't as good as people are assuming. All right, bear case, Ian, what could go wrong here? I think the bear case is that the industry doesn't grow as quickly as expected, especially the agreement cloud part of this and the DocuSign competitors, namely Adobe, begin to box it out of the growth in the space, that all of the growth in the space goes to some of

these more established competitors who can more easily spend on sales and marketing and who also have some of those platform and network effects where you've got people who are already hooked in like you guys who are already hooked into Adobe, and it just makes sense to use Adobe Sign. So I think if those types of things happen, that it'll cause quickly decelerating revenue growth before their margins can get up to those 40% that you were saying should be attainable in a business like this. Yeah. Ryan? I guess I have a few reasons, a few ways that this investment could get hurt, which was, I'd say number one is that there isn't a lot of adoption across the product suite. because I think that potentially limits their ability to raise prices with customers. If they're only relying on the e-signature, then you have to say how high are the switching costs. But if they

have notary identity and signature, they're probably going to stick with it. Second one for me is the big sales investments they're making don't bear as much fruit because there's maybe more demand saturation domestically than investors are thinking. There is the international part, But I would argue that Adobe is probably better suited to win or better positioned to win internationally because they have so many different products. And I imagine, and I might be wrong on this, I imagine their existing customer base is pretty high internationally. It depends what priority it is for them, though. You know, they could if they wanted to make it their number one priority. yeah yeah Adobe what I mean for us I get I think we're a good example that we

we used it hard we hardly used Adobe and I was like well the signature is basically free you can just bundle it yeah I imagine that might be the use case for a lot of international companies and then the last one I had was just maybe their channel partners took it in-house but I imagine if they would have been interested in doing that they would have done it already yeah that seems like one of those things that you could think of but then when you like think through it you're like why haven't they done already yeah I don't know but it's still a threat I think

from Microsoft I think especially I don't see why it's not a part of office but who knows maybe it's harder than we think it's not going to do it maybe that's that's what I would guess because if anyone could do it Microsoft could have done it if they ever would have done it they would have done

it during COVID and yeah why didn't they already there's got to be a reason yeah all right fine I mean, I think it's hard to envision a scenario where DocuSign doesn't go to the top line over the next five years. But I think the key reason you'd lose money is if growth is a lot slower than 20% a year from revenue and margins don't materialize like we think, or like we think they should. That's the big concern. And I don't think you'll, given the valuation, I don't think returns would be strong, but who knows? All right. More or less interested, Ian. We keep covering

stocks you on? So I think we know the answer, but what are the final thoughts here? So I will say on this one, actually, I'm going to say I'm a little bit less interested. So I looked over the show and it's about a half percent position of mine right now. I tend to be, so it hasn't been at the top of mind and I tend to be fairly slow to sell things. And I'm not necessarily saying that I will sell this, but this is what I'm going to keep my eye on because I think, and this kind of came up in Ryan's bear case, but i think docusign has a little bit of a problem here where it's a its main product that it's trying to build a business around is digital signatures whereas um adobe has a business

built around it built around all these other products and adobe sign is just a piece of that and so um something that's just a piece of the pie for someone else is trying to it for docusign is trying to become the launching pad for all this other stuff. And I just, I've been a little bit unimpressed with, like the growth numbers have been pretty good, but it's hard to say that they've been bad or anything like that. But I would have wished I started my position in 2019 and I would have wished that they were a little bit further along

today in terms of this agreement cloud type of idea than they are. So it's one I'm going to keep my eye on. It also feels like one that as soon as I sell it, they'll um they'll get they'll announce an acquisition for you know a 20 or 30 percent premium but um but anyways i i am just a little bit less interested i think it's it's one that i that just happened with us yeah with another company but yeah the yeah it's hard to possible to predict but yeah this is one where i think you just kind of go and i don't know and then it grows 20 forever and you're like oh well kind of like paycom like we were talking about ryan

what are you more or less interested in? Did we cut you off there? No, that's that. I was just rambling as a, as a, as a stockholder. All right. Good. I'm I'm I could, I could see, I could see the bull case playing out. Like I could see how they compound the top line and 10 million customers. I don't know. Doable doable. Yeah, I would think so. But I really, I really don't understand the competitive positioning. I'm not afraid to let this pitch kind of just go by.

Like you don't, I don't have to swing at it and it's not something I totally understand. Maybe if it were trading at a huge, like discount to what I thought they could generate in cash over the next few years, I'd be more inclined to dig a little more, but I'm going to say less interested for this. Yeah. And if that happens,

that means that your concerns about the billings growth materialized over the next five or six quarters or continue over the next five or six quarters, you might get to that point if it starts slowing down like that. Yeah, I'm in the same boat, less interested, just competitive stuff. If you have like any sort of insights on why you think DocuSign would win or maintain market share, I mean, this is a way up, but I just don't have that insight. I'd also say there's a lot of people I like as investors that like DocuSign,

which makes me wonder what I'm missing. but yeah, there could be, I think the value is there. Uh, maybe Adobe is the smaller hangup than we think, but I mean, they could, they could grow at 20%, I think for a long, long time. Um, but you gotta have, I don't know. It's hard with the valuation. You gotta have confidence that they can do that. All right. Stock for next week. This was my choice. So next week or two weeks from now, it'll be Ryan Penn. Is it Penn national gaming, Penn national gaming, AKA the bar still meme stock, right? Yeah. This is one that I've heard a lot about, obviously, because Portnoy's involved now. So that's good. We can growth hack and we'll have to automatically go

super bearish growth hack it. So he retweets it with some mean thing, right? Yeah. But yeah, going with that pen. All right. That should be fun. Remember, guys, give us a review on Spotify or Apple Podcasts. And also remember, we have the disclosure here. We are not financial advisors. Anything we say on the show is not formal advice or recommendation. Ryan and I are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Thank you all for listening. We'll see you next time.